Trust Protectors -- What They Are And Why Probably Every Trust Should Have One

The Protector is so useful, and it has become so commonplace, that the concept should almost always be discussed between planners and those looking to form trusts.

by Robert W. Wood

The concept of a “trust” is fundamentally very simple: One person holds legal title to an asset for another. If I transfer title of the family farm to you, and say, “Hold this land for the
benefit of my family,” then a trust has been created.

Because the concept of the trust has expanded so greatly over the centuries, to where now large financial institutions often hold north of a billion dollars in trust, the concept has become
daunting and lost its fundamental meaning for most folks. There are also myriad types of trusts: revocable and irrevocable trusts, grantor trusts, qualified trusts, lead trusts, life insurance
and annuity trusts, unit trusts, and even the stupidly-named “intentionally defective trust”.

The basic trust has four components: The person who creates the trust (usually “settlor” but also sometimes “grantor” or “trustor”), the trust itself and its assets, the person who controls the
trust and its assets (“trustee”), and those who are to receive the benefits of those assets (“beneficiaries”). This is shown in the following diagram:

But at the end of the day, it all comes down to one word: Trust. That word is not just a noun as in “a trust” but it is also still very much a verb as in “I trust you.” Today, we’re going to take
a vacation from the noun use of “trust” and instead focus on the verb.

For every trust there is a trustee. The trustee is the one who holds the assets — the camera in my example above, or the financial institution with the billions in assets. Whether the trust is
small or large, we have learned at least one thing after hundreds of years of trust jurisprudence: Trustees often cannot be trusted. The bigger the trust, the more likely the problem.

The temptation is just too great. The whole idea of a trust is to accumulate wealth. Where there is wealth, there is greed, and where there is greed, you’ll find temptation — and often
misconduct.

The concern is not just that of embezzlement, i.e., the trust assets (known as the “res”) disappearing into the jungles of South America. Such outright embezzlement is actually pretty rare.

The real concern is the trustee who is determined to milk the trust for fees that are reimbursable from the trust. There are lots of ways to do this, but the #1 best and leading way for trustees
to milk fees is to manufacture a dispute with the beneficiaries — this leads to litigation, and litigation leads to fees.

There are other benefits to such trust litigation, such as that the trustee can hire a law firm to help milk the trust and the trustee can sometimes receive “referral fees” from the law firm
around-the-barn or at the very least the law firm will be expected to send its new trust business to the trustee.

The trustee can also look for ways to milk the trust by firing the flames of disputes between trustees, or between trustees and other heirs. Many years ago, I was involved in one such dispute —
representing a beneficiary — where the trustee was able to bill over $1 million in fees just for the trust company representatives and its lawyers to sit idly by and watch litigation between
beneficiaries that didn’t materially affect the trust.

Another way for the trustee to benefit from the trust is to hire investment advisors to manage the trust assets, not based on how good they are on a risk-adjusted basis, but rather on how much
new trust business those advisors send to the trustee. Many trust companies now have affiliated financial investment units that serve this purpose directly — the trustee pays fees to these
advisors without even attempting to negotiate their fees down.

The problem is exacerbated by the fact that planners give so much discretion to trustees, and institutional trustees (trust companies) demand all sorts of releases from liability, etc., that make
it nearly impossible for beneficiaries to do anything about a trustee that is on the trust teat and sucking it hard.

Because estate planners are trying to sell trusts to their clients — after all, that is how they make their fees — they often don’t warn about the possibility of a trustee going off the
reservation since that might cause the clients to think twice about setting up the trust. But it happens, a lot.

There is actually a solution for this problem, and amazingly a relatively easy solution. I do not claim to know where, when or by whom the solution was originally discovered, but I do know that
the solution first became popular with so-called “offshore trusts”, which are trusts are formed in some foreign tax and/or debtor haven such as the Cook Islands or the Bahamas (no, for you
politicos out there, this is not a story about Mitt Romney).

The problem with offshore trusts is an obvious one — nobody is going to place many millions in some faraway land if those assets can just disappear. The old saying, “sunny climes is for shady
people” is based on the fact that many con-artists and other undesirables have ended up in these havens because they fled the mainland for some misconduct or another. Combine that with the fact
that the legal systems of these havens provide little real protection for those defrauded (the con-artists would disappear with the money anyway), and a brew is created that would make any
would-be trust settlor very nervous.

So, enter the concept of the “Trust Protector” or often just “Protector”. The idea behind the Protector is to have somebody who can watch over the Trustee, and terminate the Trustee for any
misconduct. Offshore trusts were increasingly drafted with provisions that gave the Protector broad discretion to terminate the existing Trustee, after which reference was to be made back to the
original trust document to appoint the successor Trustee. A simple trust arrangement with a Protector is shown below:

Originally, that was the only power the Protector had: Fire the Trustee. Nothing more, nothing less. But as the drafting of offshore trusts evolved, the Protectors were sometimes given additional
powers, such as to appoint the successor Trustee if one was fired.

There arises at some point the at least theoretical threat that if one gives a Protector the power to both fire and appoint a Trustee, the Protector will appoint herself as the Trustee. Thus,
drafting further evolved to prohibit a Protector from being the Trustee, or appointing somebody close to the Protector.

The concept of the Protector was largely unknown in the U.S. and nearly always confined to offshore trusts thought the 1990s. Then, determined to get in on the booming trust business, the states
of Alaska, Delaware and Nevada all adopted legislation that created advantages that were (they argued, and have argued since) similar to those found in offshore trusts. Whether that is true, I
will leave for another day. Suffice it to say when these states enacted trust statutes that were similar to the offshore statutes, some of those attorneys who had been drafting offshore trusts
now started drafting domestic trusts for the same purposes, and thus the Protector provisions migrated into American usage.

From there, the concept of the Protector literally exploded to where today many common types of trusts routinely have provisions for a Protector — which they should.

It is difficult to image the type of trust that should not have a Protector. Consider the most simple form of all trusts — the living trust. This is a trust that you create for your own benefit
while you are alive. You are the Trustee of your own Trust, and the beneficiary of your own Trust. You get to control and use the Trust assets freely while you are alive. So why would a living
trust need a Protector?

The problem is, you will eventually die. When you die, your heirs then become the beneficiary of the Trust, and whoever you have appointed as the successor Trustee in your trust document will
become the acting Trustee. It is this Trustee that you have to worry about — now that your dead, this new Trustee can start to milk the Trust for fees, etc., as described above, and the
beneficiaries have no recourse except to engage in expensive litigation against the Trustee, spending their dollars to fight the Trustee, and your dollars to defend the Trustee. That’s a
lose-lose as far as your intention in creating the Trust is concerned. By contrast, with a Protector, the misbehaving Trustee can be fired.

But let’s assume that instead of appointed some third-person as the Trustee, you simply make one of your heirs/beneficiaries the Trustee. The problem here is that you can’t predict the future.
Maybe by the time you die the new Trustee has developed a drug problem, or maybe the Trustee harbored a grudge against one of the other heirs/beneficiaries and now wants them to get nothing (even
though you wanted them to get their share). Without a Protector, the situation is bad. But with a Protector, the new Trustee can be fired.

The Protector is so useful, and it has become so commonplace, that the concept should almost always be discussed between planners and those looking to form trusts.

So who should the Protector be? Like the Trustee, it should be somebody that you place your trust it. But, with some exceptions, the trust document should also limit the Protector’s powers so
that the sole, only and exclusive thing that they can do is to fire the existing Trustee (or maybe also appoint a successor Protector). If you have enough faith in the person who will be the
Protector, you might also give them the power to appoint the new Trustee, but for this should normally be avoided lest they appoint somebody under the Protector’s thumb and the two of them
together loot the trust.

Where the trust is irrevocable and is meant to additionally serve asset protection purposes, the Protector should also usually not be “related or subordinate” to the person who created the trust
(known as the “Settlor” or sometimes “Grantor” or “Trustor”) or of any of the beneficiaries. There may be tax reasons for this restriction as well.

Caution also that if one starts giving the Protector too many powers, they become seriously at risk of being deemed a de facto “Co-Trustee”, with all the fiduciary duty baggage that carries. With
Protector provisions, simpler is better. A Protector provision should ideally just have three sections:

(1) Empowering the Protector to terminate the Trustee;

(2) Empowering the Protector to appoint successor Protectors; and

(3) Explicitly stating that the Protector is not a Trustee and owes no fiduciary duties to anybody or has any duty-to-act.

Sometimes Protectors are also given the ability to designate the successor Trustee — for the concerns described above about the Protector someday naming a buddy who colludes with the Protector to
loot the trust, this is a good idea only if you really, really, really trust the Protector. (See, we’re back to that verb, “trust”).

What about older trusts that do not have a Protector? Existing trusts that do not have Protector provisions can be re-drafted (the legal term is “reformed”) to add a Protector, but this may
require the consent of everybody involved and can be expensive and time-consuming depending on the applicable state laws. But suffice it to say that if the trust will hold substantial assets,
this is worth serious consideration — don’t be “penny wise and pound foolish” when it comes to preserving wealth.

In summary, the Protector can be a wonderful and necessary addition to a trust to safeguard it from trustee misconduct. Like anything else involved in legal planning, there will usually be issues
to be navigated, but in the end it will be worth it for the beneficiaries.

Byrd Settlements Inc. offers Professional Trust Protector services, which allow for the removal and replacement of a trustee/financial adviser over the life of a
trust without petitioning the court. As a 2012 Forbes
article put it, “The [Trust] Protector is so useful, and it has become so commonplace, that the concept should almost always be discussed between planners
and those looking to form trusts.”

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